Statement on Monetary Policy – May 20252. Australian Financial Conditions

2.1 Interest rate markets

Market participants’ expectations for the path of the cash rate have been revised lower.

Market-based expectations for the cash rate have declined since the US trade policy announcement in early April (see Chapter 1: In Depth – Global Economy and Financial Markets). The Monetary Policy Board’s decision to keep the cash rate unchanged in April, which was shortly before the US trade policy announcement, had little impact on market-implied policy rate expectations. A 25-basis point reduction in the cash rate is now fully priced in for the May meeting and additional cuts of 55 basis points are expected by the end of 2025, which is 30 basis points more than in February (Graph 2.1).

Most market economists also expect a 25-basis point cut in May and a similar number of cuts as implied by market pricing thereafter. Several economists have added one additional 25 basis point cut to their end-2025 cash rate expectations and have brought forward the timing of expected easing, noting progress on disinflation and downside risks to global growth.

The market curve lies within the range of model-based estimates of the neutral interest rate (Graph 2.2). In other words, there are estimates of the nominal neutral rate that are above the market curve and estimates that are below. There is a large degree of uncertainty about these estimates, where each individual model estimate is also subject to its own uncertainty.

Short-term Australian Government bond yields have declined.

Yields on short-term Australian Government Securities (AGS) have declined (Graph 2.3). Longer term yields are little changed, as uncertainty around the US administration’s policies have kept term premiums elevated. Expectations of easing monetary policy, particularly in the near term, and greater compensation for risk have both contributed to the AGS yield curve reaching its steepest level since 2021.

Market-based measures of inflation expectations are a little lower but remain anchored within the RBA’s target range. Both break-even rates and inflation expectations implied by swap markets have declined since the February Statement. However, much of the decline was driven by a deterioration in liquidity in these markets and market participants reducing their trading positions following the US trade policy announcements in early April.

Domestic markets continued to function through the recent bout of volatility, but liquidity has been low at times and markets remain sensitive to international policy developments.

In April, conditions in Australian Government bond markets were volatile and liquidity deteriorated (Graph 2.4). Market participants reduced trading positions and leverage, and market makers increased the compensation they required from market participants to facilitate transactions. Although the moves were sizable, the extent of the reduction in trading positions and deterioration in market functioning was considerably smaller than during the pandemic. Primary issuance by the Australian Office of Financial Management and state and territory issuing authorities continued, albeit at a slower pace for some. Issuers entered this period ahead of their planned funding tasks. Liquidity deteriorated in short-term interest rate derivatives markets, which contributed to sharp declines in market-implied cash rate expectations during the month.

Similarly, volatility in the markets for the Australian dollar, Australian equities and corporate bonds increased noticeably in April, but by markedly less than during the pandemic. Indicators of liquidity in these markets, including bid-ask spreads, also widened sharply in currency and corporate bond markets in early April before improving gradually.

2.2 Australian dollar

There has been considerable volatility in the Australian dollar, but on a trade-weighted basis it remains little changed since the February Statement.

The Australian dollar depreciated sharply on a trade-weighted basis following the US trade policy announcement in early April but has since recovered alongside risk assets prices to be around its February level (Graph 2.5). The Australian dollar has appreciated against the US dollar amid broad-based US dollar weakness but has depreciated against most other advanced economy currencies. This is consistent with both Australian yields having declined by more than in many of these economies and the increased uncertainty around the outlook for the Chinese economy. The Australian dollar TWI remains around the bottom of the range observed since 2022, and in real terms is slightly below the level implied by the long-run historical relationship with the forecast terms of trade and real yield differentials.

The Australian dollar has historically been an important buffer for the Australian economy, depreciating in response to a downgrade in global growth or increased global risk aversion. In this way it supports demand in Australia by making local producers more competitive. Over recent months, the Australian dollar has remained sensitive to news about the global outlook, and much of its recent resilience is consistent with financial markets that appear to be pricing in only modest downward revision to global growth. However, if the US dollar continues to depreciate during periods of heightened risk aversion, then this could, at the margin, dampen this dimension of the shock-absorbing role of the Australian dollar. The recent US dollar depreciation is discussed in more detail in Chapter 1: In Depth – Global Economy and Financial Markets.

2.3 Australian equity, credit and banking markets

The spread that Australian banks and corporations pay over risk-free rates for market funding has increased slightly.

Investors have demanded more compensation to hold riskier assets since the February Statement. The repricing was particularly sharp after the US tariff announcements on 2 April, with a more muted reaction in Australia than in the United States (see Chapter 1: In Depth – Global Economy and Financial Markets). This has largely unwound since, in line with international developments. Overall, the rise in risk premiums in Australia is consistent with a somewhat softer domestic economic outlook and lower path for the cash rate providing some support to the Australian economy if global growth slows. Even so, the still relatively low level of risk premiums leave asset prices susceptible to a sharp repricing in the event of adverse news, which could abruptly increase borrowing costs for businesses, including banks.¹

Australian equity prices declined sharply in early April but have since recovered. The decline was particularly prominent in the energy sector, in line with a sharp fall in oil prices and OPEC+’s plans to increase production (Graph 2.6). The ASX 200 has rebounded on news of smaller and delayed implementation of tariffs; however, it is still 1.6 per cent lower since the February Statement. Equity prices in sectors that are particularly sensitive to changes in the economic outlook, such as the consumer discretionary sector, have largely tracked the main index.

Spreads in the secondary market on bonds issued by banks and non-financial corporations have widened slightly. Despite this, yields on bank and non-financial corporate bonds have declined at shorter tenors as the decline in risk-free rates more than offset wider spreads (Graph 2.7). The similar widening in spreads across higher and lower rated corporate bonds is consistent with only a modest revision in market participants’ outlook for the Australian economy.

Corporate bond issuance has resumed after a brief hiatus.

International developments and heightened volatility led to a brief pause in non-financial corporate bond issuance and a longer pause in sizeable bond issuance from Australian banks (Graph 2.8). Such pauses are rare outside of year-end holiday periods. However, this followed strong non-financial corporate issuance earlier in the year. Issuance resumed in late April for non-financial corporations, which have issued mostly offshore in euros. Similarly, there was a lengthy pause in bond issuance from Australian banks starting around mid-March, which was longer than typically seen ahead of banks’ reporting of half-yearly results. Liaison with market participants suggests that the domestic market remains open to bank and non-financial corporate issuers, albeit with more challenging deal execution due to continued uncertainty. Many issuers are well funded for the months ahead and are waiting for spreads to narrow further before resuming issuance; some are also turning to bank credit, which liaison suggests is currently a more attractive source of funding for large corporations as spreads in wholesale markets have widened.

Securitisation issuance – a key source of funding for non-bank lenders – has also slowed significantly since April, following strong volumes in the March quarter. Some issuers paused their in-progress deals because of market conditions. Issuance resumed in May, at wider spreads in line with trends observed in other wholesale funding markets.

Bank funding costs have declined since the cash rate was reduced in February and as expectations for the path of the cash rate have decreased further.

Bank funding costs have declined since February (Graph 2.9). In part, this reflects banks having passed the February reduction in the cash rate through to rates paid on deposits. It also reflects a decline in bank bill swap rates (BBSW) – to which much of banks’ funding costs are ultimately linked – driven by a decline in market participants’ expectations for the path of the cash rate. Spreads between bank bond yields and the swap rate widened following the US trade policy announcements but have since narrowed in line with international developments; even at their widest, they remained well below levels reached during the pandemic. Interest rates on overnight repo – which banks use in managing their liquidity – increased a little in April following the announcements and as the RBA increased its open market operation (OMO) pricing (relative to the cash rate target).

Even if there were a significant economic downturn, the banking sector is well placed to absorb large losses and continue lending to households and businesses.² Banks remain well funded following strong issuance last year, despite the pause in bond issuance discussed above, and continue to maintain capital and liquidity buffers well above regulatory requirements.

Lenders passed through the February cash rate reduction to lending and deposit rates.

Average new and outstanding variable mortgage rates declined by around 25 basis points over February and March, reflecting the pass-through of the February cash rate reduction (Graph 2.10). The average interest rate on new fixed-rate mortgage lending was little changed over the March quarter but is 65 basis points below its early 2024 peak. Business lending rates have also declined alongside declines in BBSW rates. Banks have also lowered at-call and term deposit rates, reflecting the cash rate reduction and declines in short-term market rates.

Since April, there have been further reductions in advertised interest rates on fixed-rate mortgages alongside declines in swap rates. Some lenders have reduced advertised interest rates on some fixed-rate mortgage products by more than 50 basis points over 2025 to date. However, these reductions have had little effect on overall household financial conditions because most mortgage lending has been variable rate; in March, less than 3 per cent of new mortgage lending was fixed-rate. Banks also reduced advertised interest rates on term deposits in April alongside declines in BBSW, though these reductions were generally smaller and less widespread than those on fixed-rate mortgages.

Scheduled mortgage payments decreased following the February cash rate reduction but remain high.

Scheduled principal and interest mortgage payments decreased in the March quarter to 10.1 per cent of household disposable income. However, the value of scheduled mortgage and consumer credit payments as a share of household disposable income remains around its highest level since 2012 (Graph 2.11, blue and green bars) – and payments into mortgage offset and redraw accounts (Graph 2.11, grey bars) remain above their pre-pandemic average. The share of borrowers that are behind on their loan repayments remains low.³

Household credit growth remained steady over the March quarter, while the household credit to income ratio declined further.

Housing credit growth was little changed over the March quarter alongside soft housing price growth. Owner-occupier credit growth declined slightly over this period, offsetting increased growth in investor credit (Graph 2.12). Overall housing credit growth remains around its post-2008 average. Despite continued growth in housing credit, overall household credit (including personal credit) declined further as a share of household disposable income over the quarter to December 2024.

Growth in business debt remained strong in the March quarter.

Business debt growth remained strong in the March quarter in six-month-ended terms (Graph 2.13). Business credit growth has been broadly based across industries, supported by strong competition among lenders for business customers. Business debt has increased slightly as a share of nominal GDP since mid-2023. Profit margins for most businesses remain around pre-pandemic levels, which has supported businesses’ borrowing and debt-servicing capacity.

Endnotes

See RBA (2025), ‘Chapter 1: The Global Macro-Financial Environment’, Financial Stability Review, April. 1

See RBA (2025), ‘Chapter 3: Resilience of the Australian Financial System’, Financial Stability Review, April. 2

See RBA (2025), ‘Chapter 2: Resilience of Australian Households and Businesses’, Financial Stability Review, April. 3